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Safe Harbour: Protection for directors from insolvent trading laws

Significant reforms to Australia’s insolvency law introducing a “safe harbour” for directors who suspect their company may become or be insolvent have now commenced.

The Corporations Act imposes a duty on company directors to prevent a company from trading whilst insolvent. A director of a company can be personally liable for any debts incurred by a company trading whilst insolvent and might also have civil or criminal penalties imposed against them.

The new law provides a “safe harbor” to directors from these insolvent trading provisions. Under the safe harbor, directors will only be liable for debts incurred while the company was insolvent where it can be shown they were not developing or taking a course of action that at the time was reasonably likely to lead to a better outcome for the company than proceeding to immediate administration or liquidation.

Practically, this means company directors can now in certain circumstances remain in control of a business in financial difficulty and take reasonable steps to restructure the business, even if that causes the company to trade whilst insolvent.

For the purpose of working out whether a course of action is reasonably likely to lead to a better outcome for the company, the legislation states regard may be had to whether the person is:

properly informing himself or herself of the company's financial position;

taking appropriate steps to prevent any misconduct by officers or employees of the company that could adversely affect the company's ability to pay all its debts;

taking appropriate steps to ensure that the company is keeping appropriate financial records consistent with the size and nature of the company;

obtaining advice from an appropriately qualified entity who was given sufficient information to give appropriate advice; or

developing or implementing a plan for restructuring the company to improve its financial position.

These factors are not decisive or exhaustive.

The safe harbour will continue to apply to directors until they stop taking the course of action or the course of action stops being reasonably likely to lead to a better outcome for the company than entering administration or liquidation. The safe harbour will also end where a person starts to develop a course of action but then fails to take to take a course of action within a reasonable period after that time.

Importantly, safe harbour will not be available where the company has not been complying with its obligation to pay employee entitlements (including superannuation) or has not been meeting tax reporting obligations. During safe harbour, directors must also continue to comply with all of their other usual legal obligations including directors’ duties and continuous disclosure obligations.